The term that is. There seem to be few usages that are a greater barrier to clear thought and debate than free markets. Whether used as a term of sneering abuse to create straw-person arguments or as a slogan of the right and proper, it is ready-made to close minds and abstract away from the issues that do matter; such as the complex questions about the proper lines between private action and public rules.
Liberty and social order
The term economic freedom is distinctly preferable, since it is open to quantification and measurement–with the normal caveats and difficulties than pertain to the compilation of any index. It also connects freedom to constraints on people–either as individuals or associations–rather than to collections of transactions dealing with a particular good or service.
Not that freedom can be equated with lack of constraints on action. On the contrary, security of life, person and property is very much part of any freedom worth the name. Liberty is a value embedded in social order, not independent of it. It is entirely sensible that the most widely used index of economic freedom has security of property as one of its main criteria.
Even more fundamentally, morality is like law in that it constrains and empowers; by limiting our actions towards each other through constraints against and requirements to, morality greatly expands what we can do. If we were amoral rational egoists, we could not build functioning societies. Our ancestors’ development of a moral sense was basic to the rise of human societies.[i] A key building block of our ancestors’ moral sense was the notion of ownership, whose fundamental element is that other people acknowledge something as yours; a cognitive feature that seems to be lacking among other primates.[ii]
Libertarians often over-estimate how much morality can do in the absence of corruption-through-power while also underestimating the importance of non-state forms of power. Not to mention that even economic freedom has no simple connection to the size of government. As Justice Clarence Thomas pointed out to the Cato Institute when he was Chair of the Equal Opportunity Commission, the notion that American freedoms had been eroding since the American Revolution was not how things seemed to black folk. Nor, for that matter, to women, Jews, Catholics, queer folk … David Boaz says it well:
Has there ever been a golden age of liberty? No, and there never will be. There will always be people who want to live their lives in peace, and there will always be people who want to exploit them or impose their own ideas on others.
Conversely, the classic error of progressivists is to treat regulation and political action as some exogenous feature sitting over the top of the realm of private action. Thereby treating regulation and political action as if its public role and intent shields it from the corrupting effect of private action and motive. Or, as economist Arnold Kling puts it:
(non-classical) liberals and libertarians see the problem of “special interests” differently. Liberals view special interests as exogenous to the policy process. You have to overcome special interests to create good policy. Libertarians see special interests as endogenous. Policy is what creates them.
Putting that point another way:
money in politics are a result of the stakes that we have put on the table — the more power we give to government to reallocate wealth, the more money will be spent to have such decisions made in one’s favor.
Rules versus discretion
One of the real questions in public policy is rules versus discretion. I am generally very much against regulatory discretion [of people’s property and labour]. Not only does it encourage corruption–corruption is the market for regulatory discretion, the more regulatory discretion there is, the higher the level of corruption is likely to be–regulatory discretion will also more or less inevitably favour the wealthy, the well-connected and the articulate, for they have greater ability to gain the favourable attention of regulators. While the evidence is that money (in the form of political donations) has a weak effect on the outcome of elections, even without trying to disentangle whether money follows popularity or vice versa, money most definitely buys access to officials–hence the tendency of highly regulated industries to donate generously to both sides of politics.
Discretionary regulation also elevates the prejudices and preconceptions of regulators where they typically do not have to bear the cost of said prejudices and preconceptions. For example, modern Australian house and building design seems to suffer significant narrowing because the familiar (to regulators) is much easier to get regulatory approval for. (I was memorably regaled by the owner of a herb farm-and-store who was still very bitter at the time and expense it took him to get regulatory approval to build his store whose construction was based on centuries of experience–but not in Australia.)
Discretionary regulation can also generate serious time inconsistency problems. Such as discouraging use of emergency measures, because that will signal how bad things are; or encouraging blanket actions so as to “smother” a crisis, thereby undermining incentives for prudent behaviour. (The former CEO of Wells Fargo is still very angry at being forced to accept TARP money his bank did not need because it had not been imprudent.)
More generally, discretionary regulation raises transaction costs, and usually, as discussed above, in invidious ways. It grants control over attributes of property to people who typically do not bear the costs and consequences of exercising said control. Worse, it is an excellent avenue for privileging some groups over others. The social mercantilism which is the curse of Latin America is directly based on the Iberian model of official discretions. Regulatory discretion also operates invidiously in much of the Middle East (pdf).
Talking about “free markets”, or even just levels of “regulation”, ignores the fundamental differences involved in regulating by rules as distinct from regulating via official discretions. If there was one change I could make to the Australian Constitution, it would be to have an equivalent provision as Article 14 of the Federal German Constitution elevating rules over (pdf) official discretions.
Rules and incentives
What specifically prompted this post was (re)reading this excellent short history of banking (pdf). It makes clear how much the history of banking over the last two centuries has been a history of regulation; particularly history of governance and liability rules. Plus matters such as the tax system favouring debt over equity. Not that it is surprising that the tax system should favour debt over equity–far more voters are in the market for debt than for equity.
The consequence of waves of regulatory change has been to create institutions “too big to fail”, encouraged to go for volatility and debt where benefits were reaped by short-term investors and bank management, risks were dumped on long-term investors and taxpayers while alleged crisis-protections again and again fell prey to time-inconsistency problems.
It is not any sort of simple story about either the “failure” of “free markets” or their absence. Each regulatory change was prompted by previous experience before succumbing to changes in circumstances and/or unintended consequences. Nor does regulation have any sort of simple relationship to transaction costs. Discretionary regulation may raise transaction costs, typically in invidious ways, but rules can lower transaction costs.
For example, much of the pressure for the Latin Church to get involved in marriage came from the landholding-and-inheriting warrior elite of medieval Europe who wanted a standard set of rules about what marriage involved–who could or could not get married, who was or was not a legitimate offspring–and the Church was the only body operating across the myriad of jurisdictions and coverages of custom law that marked medieval Latin Christendom that could provide such commonality. Libertarian suggestions that the state “get out of marriage” ignore the great advantage in having a standard marriage contract or, at least, a standard contractual form. Clear rules about corporate forms and liabilities can also lower transaction costs.
Lowering transaction costs, thereby expanding possible gains from trade, is a worthy goal. But, as we can see, it does not have any simple connection to the “level” of regulation. Nor to whether a market counts as “free” or not.
Another important characteristic of markets are barriers to entry. Regulation can certainly create such barriers, but so can non-state action. Creating effectively a tort of discrimination may make people less free to discriminate but it can wildly expand the social possibilities for others. Can we really say that banning exclusion on the basis of gender, race, religion, sexuality, etc makes markets “less free”? It is true that commerce has generally been kinder to minority groups than politics; but this is also an effect that operates far more strongly in cities than in small communities, where social cartels are much easier to establish and maintain and repressed groups find it harder to reach the critical mass that encourages targeted commercial responses.
Markets are always based on implicit or explicit rules. These rules may be customary, market-generated or imposed by state or non-state action. Imposed action can take the form of rules or discretion. The rules may raise or lower transaction costs. They may create, abolish, lower or raise barriers to entry. They may protect, restrict or undermine property rights. Restrictions on property rights may lower or increase the value of the property. Much of the original pressure for zoning was to protect the value of houses by limiting permitted (pdf) local activities (or permitted local residents [pdf]).
The term free markets is a highly inadequate way of parsing these complexities. Which, of course, may be much of its appeal. Barriers to thought can be great support for the simplicities of sloganeering.
[i] Application of experimental economics and game theory suggests strongly that, in a situation of good information about each other (such as in a foraging band), trustworthy cooperation, not rational egoism, is the strategy favoured by evolutionary pressure (pdf).
[ii] There are some signs of a moral sense in other primates and some animals; it appears to be strikingly more highly developed in homo sapiens.